Samil Commentary. Korean Tax Update. Korea Removed from the EU List of Non-cooperative Tax Jurisdictions

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1 Samil Commentary February 28, 2018 Korea Removed from EU s List of Noncooperative Tax Jurisdictions National Tax Revenue for 2017 Revised Presidential Decrees of Tax Laws with Some Changes Proposed Amendments to Enforcement Rules of Tax Laws Rulings Update Korea Removed from the EU List of Non-cooperative Tax Jurisdictions The Economic and Financial Affairs Council (ECOFIN) announced on January 23, 2018 that Korea was excluded from the EU list of non-cooperative jurisdictions for tax purposes. On December 25, 2017, the EU made a decision to include Korea in its list of non-cooperative jurisdictions on the grounds that Korea s foreign investment tax incentives only granted to non-residents is a harmful preferential tax regime in light of fair taxation. Following the EU s removal of Korea from the list of non-cooperative tax jurisdictions, the Ministry of Strategy and Finance ( MOSF ) announced its plan to revise or improve Korea s tax foreign investment tax incentive system in line with international standards. Korea s National Tax Revenue Increase for 2017 The MOSF released the finalized details of 2017 national tax revenue and expenditure on February 9, For 2017, national tax revenue was KRW265.4 trillion, exceeding the 2017 budget of KRW251.1 trillion by KRW14.3 trillion or 5.7%. The figure was a 9.4% or KRW22.8 trillion increase from the national tax revenue in According to the MOSF, the latest increase in national tax revenue was largely due to the recovery in economic indicators aided by improved business results of corporations and strong exports and imports. It was also attributed to a gradual reduction in the tax credit for the gift tax return filing which led to a sudden increase in the gift of property prior to the inheritance commencement date (i.e., the date of death) thereby resulting in a rise in gift tax payment. The tax credit rate has decreased from 10% in 2016, 7% in 2017 to 5% in 2018 and ultimately to 3% in 2019.

2 Provided below is a brief summary of the tax revenue increases. Corporate income tax collection increased KRW7.1 trillion in 2017 due to improved business results. VAT collection in 2017 marked a KRW5.3 trillion increase due to a rise in domestic consumption and imports. More individual income taxes were collected as specified below: Wage and salary income tax collection rose KRW3.0 trillion largely driven by a growth in nominal wages and employment. Global income tax revenue went up KRW1.7 trillion due to an increase in the income of sole proprietors. Capital gains tax revenue grew KRW1.5 trillion, supported by an increase in real estate and the stock markets. Inheritance and gift tax revenue was up KRW1.4 trillion due to a rise in the gift of property prior to the inheritance commencement date. Revised Presidential Decrees of Tax Laws with Some Changes On January 8, 2018, the MOSF announced the government s proposal to revise the Presidential Decree of the Tax Law subsequently after the revision of the Tax Law. On February 6, the revision proposal passed the Cabinet meeting with a few changes. The revised Presidential Decree became effective following its proclamation on February 13. Two major amendments are summarized below. Postponement of the Expanded Taxation on Non-residents and Foreign Corporations for the Transfer of Listed Stocks The government decided to postpone its initial plan to tax capital gains earned by nonresidents or foreign companies from the disposal of listed Korean stocks. In the initial proposal, a wider scope of non-residents or foreign corporations holding listed stocks was supposed to be subject to capital gains tax by lowering the criterion of the listed stocks held by non-residents or foreign corporations subject to capital gains tax to 5% or more from the existing level of 25% or more. The government will review the proposed taxation as part of tax reform proposals for 2018 in the second half of 2018, while being committed to improve the system to effectively withhold tax on such gains. VAT Exemption on the Supply of Operating Right for BTO Project The original revision was supposed to provide VAT exemption for the right to operate infrastructure facilities in a BTL (Build-Transfer-Lease) (*) project whereby a private company builds the facilities and contributes them to the government in return for the right to operate the facilities. The final revision to the Presidential Decree extends the VAT exemption to a BTO (Build-Transfer-Operate) (**) project in an effort to support the private sector investment in infrastructure. (*) In a BTL project, a private company builds infrastructure facilities, transfers the ownership of the facilities to the government and receives rent from the government to cover construction costs, etc. (**) In a BTO project, a private company obtains the right to operate infrastructure facilities in return for the transfer of the ownership of the facilities to the government and receives usage fees from persons using the PricewaterhouseCoopers Page 2

3 Proposed Amendments to Enforcement Rules of Tax Laws The government announced a proposal to amend the enforcement rules of tax laws to set forth details as required by the recently amended tax laws and presidential decrees. The proposed amendments will be finalized at the end of February 2018 to be enforced in March Selected changes contained in the government s proposal include: The rate used to calculate interest on tax refunds, deemed rental for rental deposit, amounts due on the collection of over-refunded customs duty, etc. will increase from 1.6% to 1.8%, considering the average interest rate on the one-year term deposits recently offered by banks (Article 19-3 of the Enforcement Rules of the Basic National Tax Law, etc.). The recently amended Special Tax Treatment & Control Law (STTCL) expands the existing tax incentives to start-up small and midsize enterprises (SMEs) engaging in new growth-engine service businesses including computer programing, software development and other businesses as prescribed in the Presidential Decree of the STTCL. On top of those included by the recently amended STTCL, the following businesses are proposed to be added to the list of new growth-engine service businesses (Article 4-2 of the Enforcement Rules of STTCL). Classification New growth-engine service businesses Contents Advertising agency, Outdoor and exhibition advertising Market research and public opinion polling Tourism Exhibition organization under the Exhibition Industry Development Act Scientific and technical activities Technical testing and analysis Surface and geological survey, cartographic activities If a company incorporates a new company via a spin-off and transfers shares to the new company upon the spin-off, tax deferral is allowed if the new company and the company whose shares are transferred to the new company engage in the same business. Regarding this, if at least 70% of the fixed assets for business purpose of both companies is used in the same business, both companies would be regarded to engage in the same business. Under a proposed amendment, both companies will be also considered to conduct the same business if at least 70% of sales revenue is generated from the same business (Article 41 of the Enforcement Rules of the Corporate Income Tax Law). Based on the recently amended STTCL, for the fiscal years ending before or on December 31, 2020, a company shall be entitled to claim a tax credit at 5% (10% in case of medium scale companies as prescribed by the Presidential Decree and 20% in case of SMEs) on the excess of the payroll during a current year over the company s average payroll for the preceding three years if certain conditions are met. In case of SMEs, they are entitled to claim the tax credit for payroll increases if their payroll increase rate exceeds the average wage growth rate of all SMEs. The average wage growth rate of all SMEs is proposed to be adjusted from 3.3% to 3.6%, considering the wage growth rate during the recent three years (Article 14-2 of the Enforcement Rules of the PricewaterhouseCoopers Page 3

4 Rulings Update Issues for the determination of the substantive owner of Korean sourced income, the tax treaty entitlement of foreign limited partnerships, etc. This case addresses the issues as to whether (i) the intermediate holding companies in Belgium and Luxembourg would be treated as the substantive owner of the dividend from the Korea Exchange Bank ( KEB ) where Lone Star Fund IV ( Lone Star US ), a US limited partnership ( LP ) and a Bermuda company as well as six Bermuda LPs (collectively, called the investors ) made an investment via the intermediate holding companies, (ii) the foreign LPs would be entitled to the tax treaty benefits if the intermediate holding companies are not regarded as the substantive owner of the dividend received from the KEB via a Korean company acting as a custodian for the Belgium intermediate holding company, and (iii) the Korean company would be subject to the penalty for applying a tax treaty rate in case where the Belgium intermediate holding company is treated as a conduit company. The Supreme Court decided that intermediate holding companies in this case were conduit companies formed for purpose of tax avoidance, and the investors were the substantive owners of the dividend. The Court further ruled that the investors in form of LPs would be classified as corporations according to the Corporate Income Tax Law (effective prior to the amendment on January 1, 2013) and Korea s tax treaty with the country of which the respective investor is resident may apply to the Korean sourced dividend income from the KEB if such tax treaty exists. In the case, the Court determined that as the limited partners of Lone Star US were US residents and it was evident under the partnership agreement that the US LP income would be allocated to them, thereby subject to tax in the US, the Korea-US tax treaty would be applicable to the extent that the income actually attributable to the US LP would be allocated to them. In addition, noting that a withholding agent would need to withhold income tax based on the substantive owner of Korean sourced income by conducting certain due diligence to identify the person to which the income was actually attributed, the Court decided that in the case, it was not difficult for the Korean company to identify that the Belgium intermediate holding company would not be the substantive owner of the dividend and so, the Korean company would be subject to the penalty for inappropriately applying a tax treaty rate. (Daebeop2017 du 59253, ) The Court s decision led to the cancellation of KRW38.3 billion in income tax and penalties, out of a total of KRW103.1 billion in income tax and penalties assessed by the tax authority on the dividends (amounting to KRW1.2 trillion) from KEB during 2008~2011. The validity of tax assessment based on re-examination which is in violation with the principle of prohibition of duplicate tax audit The taxpayer in this case sold real estate acquired via an auction in October 2004 to a company (the Purchaser) in February In making the payment of income tax on the capital gains from the sale of real estate in April 2012, the taxpayer claimed the deduction of certain expenses ( expenses in question ) which it had paid to construction and utility service companies to remodel the real estate from November 2004 through June The district tax office conducted a tax audit of the taxpayer in October 2012 and concluded that the expenses in question would be deductible based on the supporting documents PricewaterhouseCoopers Page 4

5 the construction work and financial transactions submitted by the taxpayer as well as a confirmation letter in the name of the Purchaser that the remodelling work was underway. However, the National Tax Service (NTS) later found evidence of unreliability of the documentation submitted by the taxpayer during its internal audit on the tax office. As requested by the NTS, in April 2014, the tax office conducted a site visit to the real estate and found that the Purchaser s confirmation letter was counterfeit and the construction work had not actually been carried out and therefore, with receiving a representation letter from the Purchaser that the confirmation letter was counterfeit and no construction work was performed, the tax office disallowed the expenses in question as non-deductible expenses (called as re-examination in question). Based on the re-examination, the tax office assessed income tax including penalties on the taxpayer in October For the dispute over whether the re-examination in question would be permitted exceptionally under the principle of prohibition of a duplicate tax audit in tax laws, the Supreme Court concluded that the re-examination in this case did not fall under an exceptionally permitted one and therefore, such re-examination was in violation of the laws. As such, the Court decided that the tax assessment based on the re-examination in question would be considered illegitimate, regardless of whether the tax assessment was based on the information obtained via the re-examination or it could be made without relying on such information. (Daebeop2016 du 55421, ) The Court decision confirmed that in case where the re-examination itself is illegitimate in light of the legislative intent to strictly prevent duplicate tax audit, the tax assessment as a result of the re-examination would be illegal. It may be necessary to monitor subsequent developments including a decision at a high court since the case was returned due to the Supreme Court decision. Determining the order for the accrual of a foreign subsidiary s retained earnings for purpose of calculating indirect foreign tax credit This case deals with an inquiry of whether it is possible to measure the order for the accrual of a foreign subsidiary s retained earnings according to a method similar with the first-in, first-out (FIFO) method in calculating indirect foreign tax credits for the dividend received by a domestic parent company from the subsidiary. Article 94 (8) of the Presidential Decree of the CITL (effective prior to the amendment on February 21, 2014) had no specific provision on the timing of accrual of retained earnings out of which a dividend is paid for the purpose of calculating indirect foreign tax credits that may be claimed by the recipient of the dividend. Due to the tax law amendment on February 21, 2014, a tax provision has been added to the Article 94 (8) to adopt the FIFO method to calculate the order of accrual of retained earnings. The Seoul High Court decided that the FIFO method stipulated under the new tax provision could not be retroactively applied to the dividend which was already made prior to the tax law amendment. The Court noted that the FIFO method according to the new tax provision would newly define the order of accrual of the retained earnings out of which dividend is paid out and so, it would be difficult to assume that the FIFO method is the most appropriate for all taxpayers. (Seoul High Court 2017nu68600, ) While the High Court s decision seems reasonable, we may need to monitor a final decision at the Supreme Court for the PricewaterhouseCoopers Page 5

6 For more information, please contact: International Tax Services Alex Joong-Hyun Lee Sang-Do Lee Sang-Woon Kim Michael Kim Dong-bok Lee Chong-Man Chung Hyun-Chang Shin Chang-ho Jo Il-Kyu Cha Nam-Gyo Oh Young-Ok Kim Robert Browell Domestic Tax Services Jung-Il Joo Yeon-Gwan Oh Young-Sin Lee Chul-Jin Hwang Jin-Ho Kim Min-Soo Jung Chan-Woo Chung Bok-Suk Jung Hyungsuk Nam Dong-Jin Nam Seungdo Na Sung-Wook Cho Sun-Heung Jung Youngsuk Noh Hye-Won Choe Transfer Pricing & International Trade Heui-Tae Lee Henry An Won-Yeob Chon Junghwan Cho Global Mobility Services (GMS) Younsung Chung Corporate Administrative Services (CAS) Jina Park Inheritance & Gift Tax Services Hyun-Jong Lee Financial Tax Services In-Hee Yoon Taejin Park Hoon Jung Nonprofit Corporation Service Center YoungSun Pyun Small and Midsize Enterprise and Startups Service Center Bong-Kyoon Kim Knowledge & Innovation Han-Chul Cho Samil Infomine/ Samil Academy Sang-Keun Song Mirah Kang Samil Tax Corp. Nam-Bok Jo PwC Customs Service Sang-Tae Moon Stay current and connected. Our monthly newsletters and ad hoc alerts keep you updated on Korean tax laws as well as significant business regulatory developments. Please send an if you like to subscribe or want to add someone to the mailing list to: The information contained in this publication is for general guidance on matters of interest only and is not meant to be comprehensive. The application and impact of laws can vary widely based on the particular facts involved. For more information, please contact your usual Samil PwC client service team or professionals listed above. C 2018 Samil PricewaterhouseCoopers. All rights PricewaterhouseCoopers Page 6